Accounting Policies and Procedures Followed by J Sainsbury Plc and Tesco Plc - Statistics Project Example

Financial Reporting and Control Executive Summary In the first part the accounting policies and procedures followed by J Sainsbury Plc has been discussed briefly with an emphasis on the notes relating to fixed assets; operating profit; Property, Plant & Equipment and Provision. The method of depreciation followed by the company has also been discussed including the bases with respect to the various assets. In the next part the financial ratios of J Sainsbury Plc has been compared to its rival Tesco Plc. The ratios relating to liquidity, profitability, gearing and investment have been computed for the purpose of analysis. Current and quick ratios have been calculated under the liquidity head. For profitability, ratios relating to gross-profit margin and net profit margin have been prepared. Debt-equity ratio has been computed to highlight the gearing position. Return on equity and return on asset have been computed under investment. The ratios relating to the years 2009 and 2008 have been computed to highlight the trend in the direction of the ratios. A comparison with the industry has been done to highlight the position of the company in the industry. In the next part the purpose and nature of the financial statements has been discussed. After this the role of the audit committee in monitoring internal controls and practices has been discussed. This is followed by a discussion on the nature and purpose of Independent Auditor’s Report. Finally the internal auditor’s opinion and Statement on Corporate Governance with respect to internal audit and internal control has been briefly discussed. Table of Contents Executive Summary 1 Introduction 4 Analysis of accounting conventions in Sainsbury 4 Analysis of financial ratios 6 Liquidity and Working Capital- 6 Profitability- 7 Investor- 7 Gearing- 8 Trend- 8 Industry comparison- 9 Purposes of the financial statements 9 Purpose of Audit Committee 10 Statement on Corporate Governance 12 Recommendation 12 Annexure- 15 Introduction The financial statements of the company give summarized information about the financial performance of the company in the respective year. These are prepared as per accounting concepts and conventions. Ratios are computed using the information presented in the annual reports. These ratios are then compared with the previous years to identify any improvements or deteriorations. This can also be used for inter- industry comparison. Analysis of accounting conventions in Sainsbury The financial statements of the company have been prepared as per International Financial Reporting Standards (IFRS). Basis of preparation- The financial data presented in the financial statements are in terms of sterling and have been rounded off to the closest million. Other than derivatives, “available for sale” financial assets and investment properties, which have been measured at fair value, all other items in the financial statements have been reported under “historical cost conventions”. The revenue is recognized after the significant rewards and risks relating to services and products, have been transferred to buyer, and therefore can be reliably measured. Land and buildings are reported at cost minus accumulated depreciation and any loss on impairment. In the due course of the construction the properties are reported at cost minus any recognized loss relating to impairment. Vehicles, equipment and fixtures are stated at cost minus accumulated depreciation and any loss relating to impairment. The amount of depreciation is calculated on a straight line basis taking the following bases into consideration- For leasehold properties and freehold buildings- 50 years or lease term, whichever is shorter. Vehicles, equipment and fixtures- 3 to 15 years. No depreciation is charged on freehold land. No depreciation is charged on land and buildings that are under construction as well as non-current assets that are held for sale. Operating profit is reported after crediting or charging for the items like- employee costs, depreciation expense, amortization cost, profit earned on property sale, costs pertaining to approach from “Delta two”, costs relating to “Office of Fair Trading dairy inquiry”, Fair value gain realized on other financial asset, credits or charges relating to receivables impairment, gains on foreign exchange, operating lease rentals- land & building, other leases and receipts on sublease payments. As per IAS 36 “Impairment of Assets”, the Group has taken each store as a “cash-generating unit (CGU)” for the purpose of impairment testing. On every reporting date the CGUs are tested to check for any impairment in the case of impairment indications. The amounts that are recoverable on CGUs are based on “value in use” that is computed as per the cash flows that are anticipated to be generated by the units based on the recent budget and forecasted estimates. The discount rate is taken at 10 percent, which is the pre-tax weighted average cost of capital of the Group. Provisions have been charged to the Income statement under following heads- Additional provisions, Unused amounts reversed, Utilization of the provisions and amortization of discounts. The unused provisions and provisions utilized are actually deducted from the overall provisions in the Income Statements. Analysis of financial ratios Ratio analysis is an effective tool of comparing the results with the past figures. This helps in identifying the areas that need management attention. Liquidity and Working Capital- Current ratio is an indicator of a company’s liquidity position. It highlights whether the company is capable of meeting its short term obligations. The current ratio of J Sainsbury Plc for the years 2009 and 2008 is 0.54 and 0.61. This is lower than the current ratio of 0.78 of Tesco Plc, for the year 2009. Ideally this ratio should be 2. A ratio less than 1 indicates that the liquid resources of J Sainsbury Plc are not sufficient of taking care of its short term liabilities. The quick ratio of the company highlights its ability to honour the short term liabilities with the most liquid resources. A high quick ratio indicates the sound positioning of the company (Investopedia, 2010). The quick ratio of J Sainsbury Plc for the years 2009 and 2008 is 0.30 and 0.35 respectively. This has deteriorated over the previous year. The quick ratio of J Sainsbury Plc is less than half the quick ratio of Tesco of 0.63. There has been an improvement in this ratio for Tesco Plc. Profitability- The gross profit margin is expressed as Gross Profit/ Sales. For the year 2009 J Sainsbury Plc has a Gross Profit margin of 5.48%. This has reduced as compared to the last year’s margin of 5.62%. The gross profit margin of Tesco Plc on the other hand is 7.76%and 7.67% for the years 2009 and 2008 respectively. Sainsbury Plc has a low gross profit margin as compared to Tesco Plc. This highlights that the former has failed to manage its operating costs efficiently resulting in low gross profit margins. The net profit margin of Sainsbury Plc is much less as compared to Tesco Plc. For 2009 the former reported a net profit margin of 1.53% which is lesser than its previous year’s margin of 1.84%. The low net profit margin indicates that the company has not been able to manage its administrative expenses efficiently resulting in high costs and low profitability. On the other hand, the net profit margin of Tesco Plc is significantly high at 3.99% which is more than double as compared Sainsbury Plc. Investor- The return on equity (ROE) is an indicator of the wealth generated by the company for its shareholders. For 2009, Sainsbury Plc had a ROE of 6.60% marking a marginal fall over the previous year’s return of 6.67%. This is much less as compared to Tesco Plc which reported a ROE of 16.67% in 2009 which is more than double the return generated by Sainsbury Plc. The investors are generally interested in companies that generate good returns on their investment making Tesco Plc the preferred choice over Sainsbury Plc. The factor that affects the bottom-line of the company is whether it uses its debts advantageously. This means that the profit earned on the borrowed funds should be more than the interest incurred for it (Tracy, 2008, pp. 288). The Return on assets (ROA) indicates how efficiently the company is using its assets to generate earnings. The ROA of Sainsbury Plc for the years 2009 and 2008 is 2.88% and 3.25%. This shows that the return generated by the company has declined over the last year. The ROA of Tesco Plc is reasonable at 4.70% for the year 2009. The low ROE of Sainsbury Plc highlights the inefficiency of the company’s management in utilizing the available resources. Gearing- The gearing represents the leverage position of the company. A high debt-equity ratio indicates that the company is overleveraged. The debt-equity ratio of Sainsbury has risen marginally over the last year from 1.05 to 1.29 in 2009. This is mainly due to the increase in the debt position of the company in 2009. Tesco Plc on the other hand is highly geared as is evident from the debt-equity ratio of 2.54. The debt position of Tesco Plc has increased substantially from £18262 million in 2008 to £33058 million thereafter (J Sainsbury Plc, 2009; Tesco Plc, 2009). Trend- The financial ratios of Sainsbury exhibit a falling trend. This is evident from the fall in the profitability margin, liquidity ratios of the company. The gross as well as net profit margins of the company have declined in the year 2009 as compared to the previous year. Industry comparison- The gross profit margin in the food and retail industry is 23.3% which is much higher as compared to Sainsbury (MSN Money-a, 2010). The liquidity ratio of the industry is 1.2 which is much higher as compared to the liquidity ratio of Sainsbury Plc. Moreover the debt-equity ratio prevailing in the industry is 0.72. This is less than that of Sainsbury. It shows that the company is highly leveraged. It may be possible that the company is not able to make use of the growth opportunities due to the increased debt burden (MSN Money-b, 2010). Purposes of the financial statements The four financial statements of the company include Income Statement, Balance Sheet, Cash Flow Statement and Statement of changes in net assets (Cleverley and Cameron, 2007). The Income Statement is a presentation of the expenses incurred and income earned by the business in the respective year. This is also referred to as Profit and Loss Statement as it measures the profit earned or the loss suffered by the business in the year. Balance Sheet contains information relating to the assets and liabilities of the business as on a particular day. The assets comprises of plant & machinery, equipment, receivables, inventories, cash & bank balances, intangible assets etc. Liabilities consist of creditors, loans, overdraft, capital etc. Any amount that is outstanding in a year is shown on the liability side of the Balance Sheet. Cash Flow Statement highlights the cash flows activities of the business relating to financing, investing and operating. Statement of changes in net assets presents the change in the position of the assets over the previous year. Purpose of Audit Committee The purpose of the audit committee is to assist the Board of Directors of the company in discharging and monitoring the responsibilities relating to audit. Its main functions include- Exercise internal control practices for the development of an efficient control environment so as to achieve the business objectives Monitoring the risk assessment and internal control practices for ensuring the implementation of the provisions relating to “Board of Regents Policy: Internal Control” (UNIVERSITY OF MINNESOTA, 2009). Act as a direct communication link between the independent public auditor and internal auditor and Board (UNIVERSITY OF MINNESOTA, 2009). Independent auditor’s report The Independent auditor’s report states their professional opinion regarding the financial statements. They are in charge of assessing the fairness of the financial statements preparation and attest the same through audit report. The report must be concise and clear regarding the results and findings of the audit conducted. The auditor can express an unqualified opinion, qualified opinion, adverse opinion or disclaimer in the report. An unqualified opinion states that the financial statements present a fair picture of the material aspects of the business. A qualified opinion means that, except in certain matters, the financial statements present a fair picture of the financial position. An adverse opinion means that the financial statements do not give a fair view of the financial position. In a disclaimer the auditor does not state his opinion about the financial statements (Braiotta, 2004, pp. 373). Statement on Corporate Governance Corporate governance ensures an efficient discharging of responsibilities by practising and developing high corporate governance standards. The Board is in charge of maintaining internal control systems that can reasonably assess the effectiveness of internal controls and regulatory compliance. The Board forms a transparent relationship with the independent auditors, with audit committee as the principal link. Through audit committee the external auditors can bring to the Board’s attention any matter relating to accounting standard compliance and other regulatory requirements (CWorks, n.d.). Recommendation An analysis of the financial statements of J Sainsbury Plc reveals that the company’s performance has deteriorated over the last year. There has been a fall in the important ratios of the company relating to profitability and investment returns. In terms of returns the company does not look very impressive. The return offered by the company is much less as compared to the industry standards. Therefore the investors must be cautious in making an investment in the company. Reference Braiotta, L. 2004. The audit committee handbook. John Wiley and Sons. CWorks. No date. Statement on Corporate Governance. Available at: http://cworks.listedcompany.com/misc/corporate_governance.pdf [Accessed on April 1, 2010]. Cleverley, O.W. Cameron, E.A. 2007. Essentials of health care finance. Jones & Bartlett Publishers. Investopedia. 2010. Quick Ratio. Available at: http://www.investopedia.com/terms/q/quickratio.asp [Accessed on April 1, 2010]. J Sainsbury plc. 2009. Annual Reports. MSN Money-a. 2010. Industry. Profit margins. Available at: http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=ProfitMargins&Symbol=WFMI [Accessed on April 1, 2010]. MSN Money-b. 2010. Industry. Financial Condition. Available at: http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=FinancialCondition&Symbol=WFMI [Accessed on April 1, 2010]. Tesco Plc. 2009. Annual Report and Financial Statements 2009. Tracy, J. 2008. Accounting For Dummies. Wiley Publishing Inc. UNIVERSITY OF MINNESOTA. 2009. Subd. 3. Purpose. AUDIT COMMITTEE CHARTER. Available at: http://www1.umn.edu/regents/policies/boardoperations/Audit_Charter.pdf [Accessed on April 1, 2010]. Annexure- Read More